After over a decade of rock bottom interest rates and money printing, we have entered a new phase this year with interest rates rising and the money taps being turned off.
Ostensibly this has been to combat inflation. Inflation has soared due to a perfect storm of the war in Ukraine, supply chain issues (particularly due to Chinese Covid lockdowns), the switching off of less climate friendly energy sources and the pent up demand of us all being released from our Covid prevention measures. Many of these issues are relatively temporary in nature and not related to interest rates. As a result there is an expectation that inflation will become less dramatic in due course, however it has to be said that near zero interest rates and unlimited money printing were unlikely to last forever.
Interest rates in the UK have risen to 3.5% and inevitably this higher cost of money has made investors reassess the price they are willing to pay for things like: a fixed annual interest return, the annual profits that companies generate and the annual rent that property generates. In general overall, the interest, profits and rent haven’t actually changed too much, it is simply how much of a multiple of the annual returns are investors willing to pay.
Now that this adjustment in value has occurred, attention is turning to the long term questions going into the New Year: Where will inflation settle at? How high will interest rates be raised to combat inflation? When will the war end and China reopen so we can get back to some sense of normality? How will we ensure energy supplies whilst still tackling climate change?
As the famous investment saying goes: the solution to high inflation is high inflation. In effect, the price of something cannot double every year in perpetuity as eventually we will not be able to afford it, will stop buying it and there will be more product than demand, pushing the price back down. Whilst it seems hard to imagine at present, in the absence of new world events, it seems likely inflation will need to at least “settle” somewhat. This will ease the pressure on central banks to keep raising interest rates and therefore reduce the pressure on asset prices.
Once things settle somewhat, investors will be able to focus back on the long term fundamentals of why we own investments. We own fixed interest holdings for a defined income return, we own share of profitable companies for hopefully growing profits and dividends, we own investment properties for a long term rental income. We don’t own investments in the “hope” of perpetual increases in price regardless of fundamentals.
In the environment of 2022, the pressure has found out the weaker, overindebted and poorly run businesses. Companies that have been able to continue to generate profits and indeed pass on inflation costs to their customers are now more attractively priced as their profits hold up and in some cases, have increased. In a way, this environment has also flushed out the investors (particularly the gambling day traders) who were investing blindly in the hope that prices would always rise regardless of the underlying income or profits generated by the investments. For steady, long term investors, prices are now more attractive and arguably realistic and their plans are not off track.
We go into the new year cautiously optimistic but also realistic that there are events that are outside our control. We cannot control the Covid Policies of China, we cannot control the course of the war. But we can control the quality of the investments we own and understand that fundamentally, people will continue to buy goods and services (they have to eat for example) and as a result, regular profits are there to be earned by quality businesses.
(Fraser Wilkinson pictured below)
“2022 has been a challenging year for investors with portfolios at all risk levels showing a negative return for the 12 month period” says Director and Chartered Financial Planner, Paul Gibson
“A year of a fall in markets is to be expected when investing for the medium to long term, it is part of the economic cycle. Clients will have established a financial plan with us and it is important to remember that portfolios will have good, bad and average years. Focus on your long term objectives, try to ignore ‘the noise’ when markets are depressed and speak to your adviser if you are concerned. Now its time to sit tight and wait for markets to recover as they have done previously – lets hope for a positive 2023!”
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